Czech Central Bank Will Probably Cut Main Rate to Record Low

By Peter Laca and Krystof Chamonikolas - Jun 28, 2012 5:00 AM GMT+0700.

The Czech central bank will probably cut interest rates for the first time in two years to support the economy after faltering demand sparked a recession and the government’s borrowing costs sank to the lowest ever.

The Prague-based Ceska Narodni Banka will drop the benchmark two-week repurchase rate by a quarter-point to 0.5 percent at a meeting today, according to 20 of 24 analysts in a Bloomberg survey. Such a reduction would deepen the discount to the European Central Bank’s benchmark rate.

As the ECB lifted and then lowered its refinancing rate by a half point to 1 percent last year, the Czechs held steady because consumer spending wasn’t fueling inflation. Investors’ bets on lower interest rates pushed government bond yields to record lows, and added impetus to the biggest quarterly koruna decline against the euro since 2008.

“The Czech National Bank has the comfort of focusing on a disappointing growth performance against negligible core inflation pressures,” Gillian Edgeworth, an analyst at UniCredit SpA (UCG), said in a June 25 note. Shrinking gross domestic product, “particularly weak” retail sales data for April and core inflation at 0.5 percent are among reasons for a quarter- point rate cut, Edgeworth said.

Tax Increases

Forward-rate agreements fixing the three-month interbank rate in three-months were quoted at 0.99 percent yesterday, compared with the Prague interbank offered rate, or Pribor, at 1.21 percent, according to data compiled by Bloomberg. The yield on two-year government bonds fell seven basis points to 0.9 percent yesterday, the lowest since at least 1997. The koruna strengthened 0.2 percent to 25.85 per euro, near the weakest intraday level since Nov. 28.

Czech rate setters are assessing the impact of the government’s tax increases on shop prices and the effects of the euro area’s sovereign-debt crisis on the economy. The bank’s board split three ways over monetary-policy settings at the last meeting on May 3. Governor Miroslav Singer and Vice-Governor Vladimir Tomsik voted for a rate cut, while four members wanted no change. One sought a quarter-point increase.

The Czech central bank chief differs in his assessment of inflation trends from policy makers in Poland, the EU’s largest post-communist economy. The Narodowy Bank Polski was the only bloc member to increase borrowing costs this year as inflation exceeded the upper end of the target range since January 2011. Singer is discounting a spike in Czech inflation above the bank’s target in 2012, spurred by a tax increase and fuel costs.

Confidence Falls

The inflation rate dropped to 3.2 percent in May, the lowest this year, from 3.5 percent in April. The reading was 0.2 percentage point lower than the central bank forecast. Inflation relevant for monetary policy, defined as price growth adjusted for the primary impact of changes in indirect taxes, eased to 2 percent in May, matching the bank’s target.

Consumer confidence fell to the lowest in almost 13 years in May, while retail sales declined 4.1 percent in April, the largest drop in two years and compared with a 5.5 percent increase in Poland.

“We are essentially stagnating because of, I believe, the uncertainty of almost every player in this economy, and because of fiscal measures that are necessary to keep our fiscal side balanced,” Singer said at a conference in Prague yesterday. “Inflation-wise, we are not in big trouble,” he said, adding that the only sources fueling price growth are the sales-tax increase and influences from outside the Czech Republic.

Headline inflation may exceed the bank’s forecast of 1.5 percent in the second quarter of next year if the government pushes through another set of measures aimed at boosting budget revenue, including an additional increase in the sales levy and a new income-tax rate for higher earners. A boost in taxes may further curtail consumer spending and limit demand-driven inflationary pressures, the bank said.

Weaker Koruna

Koruna developments may be key for central bank board members when deciding on rates today as the currency has weakened 3.5 percent to the euro since May 2, one day before the previous policy meeting. The weaker koruna is easing monetary conditions by making exports cheaper, while adding to inflationary pressures as imports become more expensive.

“The only factor that could perhaps discourage central bankers from lowering rates is the weak koruna,” Václav France, an analyst at Raiffeisenbank AS in Prague, said in an e-mail yesterday. “If there is a cut in rates, the koruna shouldn’t react. If the rates stay unchanged, it will be a positive impulse for the koruna.”

To contact the reporters on this story: Peter Laca in Prague at placa@bloomberg.net; Krystof Chamonikolas in Prague at kchamonikola@bloomberg.net

To contact the editor responsible for this story: Balazs Penz at bpenz@bloomberg.net